There are varying views on monetary policy among stakeholders. One compelling argument for cutting rates further into a single digit is to facilitate a growth revival while keeping real rates around 2 percent on a forward-looking basis. The IMF and government project inflation to reach 7.5 percent in FY26, while analysts’ forecasts are even lower. Thus, lowering rates by another 2 percentage points this year cannot be ruled out.
The objective is to revive economic growth and generate employment. The core question is whether private credit will rebound enough to create growth momentum. The chances are not high. Although interest rates have already halved from their peak, there are few signs of direct growth through private credit, either producer or consumer. More important bottlenecks, such as higher taxation and energy prices, continue to suppress demand. Additionally, the removal of wheat support prices keeps rural demand in check.
However, there are risks to cutting rates too quickly. There is an intrinsic link between interest rates and exchange rates: keeping rates high reduces pressure on currency depreciation, and vice versa. Already, the currency is depreciating. Recently, authorities have tried to persuade exchange companies and banks not to let the PKR/USD parity slide. It would be wiser to proceed cautiously to avoid panic in the currency market.
Another question is why demand is not picking up, and whether lowering interest rates further can trigger growth. Private credit remains low. Most industries already have excess capacity, so few are interested in expansion, and working capital needs are limited. Auto loan demand, historically highly correlated with interest rates, is suppressed by the SBP’s auto credit limit of Rs 3 million and a three-year loan tenor. The SBP does not want a surge in auto loans. Furthermore, the government has maintained high taxes on cars imposed after the 2022 crisis.
Most areas of demand are indirect. Lower interest rates can shift investment from low-risk classes (such as fixed income) to riskier avenues such as the stock market, real estate, and commodities trading. The stock market is booming, but even with rates cut in half, real estate remains stagnant, likely due to higher taxation. Stocks are already taxed and are being re-rated, but the case is the opposite for real estate trading. When real estate prices rise, construction typically improves as well. Further lowering rates may not boost construction or revive growth in the steel and cement sectors.
In food commodities, there are signs of hoarding as the opportunity cost of holding inventory is lower. This is evident in the recent increase in sugar prices, and wheat is likely to follow. The government does not have sufficient stocks, and a domestic supply shortfall looms. Prices are expected to rise after September. Lower rates strengthen this thesis which is not good for forward looking inflation.
One sector that benefits significantly from lower rates is textiles. Margins are squeezed due to higher taxation, but lower rates improve net margins for leveraged companies. Additionally, lower rates may allow the currency to depreciate, benefiting exporters. However, the key to export growth is the US tariff policy toward Pakistan relative to other competitors. It is wise to observe how these tariffs develop.
Another important indicator for the currency is the interest rate differential between the US and Pakistan, which is already below the historical average. The US is expected to begin cutting rates soon. It is best to monitor both US interest rates and trade tariffs before advocating single-digit rates at home.
In summary, the target of generating growth argues for rate cuts, but there are doubts, especially given the risks of inflation resurgence. Food commodity prices (especially sugar and wheat) are likely to rise, potentially boosting rural demand. In urban areas, wage pressures, particularly in the services sector, persist. The incentive to hold dollars may increase as rates fall, with importers anticipating further currency depreciation, given declining foreign currency borrowing. This trend may accelerate.
The current account could come under pressure, and banks are already delaying letters of credit (L/C) issuance. These delays could increase, prompting more administrative measures to keep the external account and currency stable, which may not be healthy for the market overall. The SBP should adopt a measured approach in its upcoming policy review on Wednesday, favoring a wait-and-see stance.
Copyright Business Recorder, 2025
Ali Khizar is the Director of Research at Business Recorder. His Twitter handle is @AliKhizar